Weakest employment market since the Great Depression

Recently Allan Meltzer, a former Vice Chairman of the Federal Reserve, wrote a widely noted and provocative article in the Wall Street Journal called “What Happened to the ‘Depression?’” He called for an end to deficit-inducing stimulus because the cries of Depression from noted mainstream economists has been proven false. His thesis is that these economists, most notably Paul Krugman and IMF Chief Economist Olivier Blanchard, are hyping the downturn to support a specific policy agenda with which he vehemently disagrees.

How severe would it have been had specific policy measures not been taken?

Irrespective of the severity of the downturn, were these the right steps to have followed?

I delineate the argument as such because Meltzer, I believe purposely and misleadingly, conflates these issues for political purposes. His goal is to present a narrative in which stimulus, especially deficit-inducing stimulus is seen as wasteful and misguided. This may be the case (although I do believe certain types of stimulus are purposeful). I don’t intend to examine that issue because it is as much political and ideological as it is economic. It distracts from the real question: how severe could this downturn have been?

Nowhere near the Depression

When it comes to this core question, I agree wholeheartedly with Meltzer. This is not the Great Depression II, nor will it be, nor was it likely to have been. I wrote a fairly personal post on this very point at the height of the panic last year called “Worse than the Great Depression.” My point was that America, the world really, is much richer than it was in 1929. The social safety net is much more robust. And policy makers are more knowledgeable than they were eight years ago. Comparisons to the Great Depression are misplaced.

But, Allan Meltzer is incorrect when he compares this downturn to 1973-75. The present downturn is clearly more severe. The financial system has been hit very hard with a number of prominent institutions either dying (Lehman, Bear Stearns, Washington Mutual, Merrill Lynch and Wachovia) or being critically wounded (Citigroup and Bank of America).

When one looks globally, the same is also true. Large or venerated institutions like RBS, Lloyds/HBOS, Hypo Real Estate, Dresdner/Commerzbank, Fortis, Dexia and UBS have all collapsed or been forced into the arms of government. In 1974, we had a financial crisis that centered on the death of Herstatt in Germany and precipitated the first real modern crisis of financial contagion since Creditanstalt in 1931 (hence the term Herstatt risk and the reason for Bear Stearns’ bailout in 2008). But, this financial crisis was mild in comparison to what we have seen recently.

Employment is the difference

The real difference is the weakness of consumers, particularly in Anglo-Saxon countries and Spain. Here, we see a mountain of debt, huge losses in wealth and a bevy of macroeconomic disequilibria without parallel – even in the Great Depression.

What’s more is this is indeed the worst period of employment growth in the U.S. since record keeping began during the Great Depression. Below is a chart showing the 100-month change in seasonally-adjusted non-farm payrolls. This could generally be considered a length of time which spans an entire business cycle. In April of 2009, we saw the first period during which non-farm payrolls decreased over a 100-month span.

What this data should make plain is that the downturn we are experiencing is really an outgrowth of the recession and jobless recovery of 2001-2003. Only through the extraordinary efforts of Alan Greenspan in inflating a housing bubble to replace the telecom and technology bubble were we able to escape this downturn relatively unscathed.

Bubble economics has created a calamity

So, my conclusion is three-fold.

This is not the Great Depression II, but it is indeed a serious crisis – much more serious than 1973-75. That makes this downturn more akin to the Great Depression than it does to other economic recessions in the post World War II period.

The downturn would have been greater had it not been for the policy response. Policy makers have thrown everything they could at the problem – some would say too much! It is simply misleading to suggest that economic stimulus including fiscal stimulus has not pumped up the economy. I would argue that we are about to see that not enough stimulus was provided to avoid a potential relapse – something I have been saying since before Obama came to office. It is this fact that has left the door open to claims like Meltzer’s.

I will leave it to the ideologues to debate the correct response. But if a 1937 outcome arrives, you will know why. I have said my piece about easy money; it was ineffective in bringing on sustainable recovery in 2001 and precipitated a more calamitous downturn. I don’t think things will be different in 2009. But, that leaves the question of budget-busting fiscal stimulus – the crux of Meltzer’s article. There are some who think it better to swallow a bitter pill and let the downturn happen a-la Warren Harding in 1920-21 (see Wikipedia here and here). I have sympathy (as I suspect Meltzer does) for that view because of malinvestment that stimulus is likely to induce; Just look at China today. But I do think it is that sort of severe downturn which gave us Hitler and Mussolini and I worry about a 1937-style outcome.

There are no easy answers here. Difficult policy choices must be made and the outcome based on these choices is far from clear. However, Allan Meltzer is demagoguing this issue and not being straight about his ideological agenda. It would be infinitely preferable if we could discuss this issue on the merits and not based on a fiction of ideology.

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator in print and on television for the past decade. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

At first I didn’t see the updated chart on your web site. This is most
interesting. IMO this puts the “boom” of the late ’90s in its place as
much more of a financial bubble than a transformative “true” boom.
Good times just rolling along for “banksters” but all the malinvestment
spawned by the boom has left us struggling to find a theme.

PS Did you come up with the term “Fake Recovery”? Love it . . .

Larry/DoctoRx

Anonymous says 9 years ago

Nice article ed. Unfortunately the dopes that created this disaster are still running the show. It is time to clean house and take the medicine now before this spirals into something far worse for our country. 10-20 years of malinvestment cannot be solved in a year or two.

100%. The question is how best to undo this malinvestment. Libertarians would tell you that we need to allow free markets to work. Keynesians would advocate stimulus.

Either way, we are facing a long, hard road if we want to correct prior malinvestment and return to sustainable long-term economic growth. The last generation of growth was pure fiction which came largely from taking on more debt.

Anonymous says 9 years ago

Any explaination for the surge in gold recently?
Have we hit the inflection point on the dollar?
where does one place your money when the fed is debasing the currency and the economy has ratched down several notches?
Sitting in a bank savings account or money market earning zilch is not going to cut it while the value of the dollar could possibly plunge any day.

“But I do think it is that sort of severe downturn which gave us Hitler and Mussolini and I worry about a 1937-style outcome.”

We’re in the grip of a two party, one party state that hands the operation of the economy over to the largest banks and corporations, that lies us into aggressive wars and proudly announces that it tortures people and you’re worried about us falling into fascism? Its not clear to you that that’s already happened? Don’t let the absence of marauding street toughs fool you, they’re doing their warm ups at the town hall meetings.

When it comes to this core question, I agree wholeheartedly with Meltzer. This is not the Great Depression II, nor will it be, nor was it likely to have been. I wrote a fairly personal post on this very point at the height of the panic last year called “Worse than the Great Depression.” My point was that America, the world really, is much richer than it was in 1929. The social safety net is much more robust. And policy makers are more knowledgeable than they were eight years ago. Comparisons to the Great Depression are misplaced.”

Two things that might be worth reflecting upon: 1) Your outlook would probably a lot more sober if you were facing unemployment yourself. 2) Social safety net? Are you insane? Charities and soup kitchens and shelters are already closing down because they’ve run out of funding. States writing IOU’s. Unemployment Insurance? Good grief, is that what you’re counting on? Either you are being paid to lie, or you incredibly closed off to the real world, or both. People knew vaguely how to survive back then. These days knowing how to program the microwave is considered useful. Millions of people who don’t know how to care for themselves adequately in a crisis, with millions of guns. Do the math.

What we are still facing is potentially worse than the Great Depression. Government at least remained solvent through the thirties. It was running surpluses. Debt was liquidated and asset prices fell and there wasn’t much consumer debt, so all you had to do was to stimulate business men’s animal spirits and convince people who were hoarding money to spend it. Today, we have preserved all the debt, the government continues functioning only by the grace of China, credit is only available for speculation, business operates at sixty percent of capacity with no incentive to add new investment, and those in leadership roles are simply cheerleaders for a return to business as usual, which means blowing up another bubble. Unlike in the thirties, we cannot even look forward to a war which would destroy excess capacity (hopefully in other countries of course). So what exactly makes you think this looks like 1975?